The Dark Side of Universal Banking: Financial Conglomerates and the Origins of the Subprime Financial Crisis

The Dark Side of Universal Banking: Financial Conglomerates and the Origins of the Subprime Financial Crisis

Electronic copy available at: http://ssrn.com/abstract=1403973 THE GEORGE WASHINGTON UNIVERSITY LAW SCHOOL PUBLIC LAW AND LEGAL THEORY WORKING PAPER NO. 468 LEGAL STUDIES RESEARCH PAPER NO. 468 The Dark Side of Universal Banking: Financial Conglomerates and the Origins of the Subprime Financial Crisis Arthur E. Wilmarth, Jr. Connecticut Law Review, Vol. 41, No. 4 (May 2009) Electronic copy available at: http://ssrn.com/abstract=1403973 963 CONNECTICUT LAW REVIEW VOLUME 41 MAY 2009 NUMBER 4 Article The Dark Side of Universal Banking: Financial Conglomerates and the Origins of the Subprime Financial Crisis ARTHUR E. WILMARTH, JR. Since the subprime financial crisis began in mid-2007, banks and insurers around the world have reported $1.1 trillion of losses. Seventeen large universal banks account for more than half of those losses, and nine of them either failed, were nationalized or were placed on government- funded life support. To prevent the collapse of global financial markets, central banks and governments in the U.S., U.K. and Europe have provided $9 trillion of support to financial institutions. Given the massive losses suffered by universal banks, and the extraordinary governmental assistance they have received, they are clearly the epicenter of the global financial crisis. They were also the main private-sector catalysts for the credit boom that precipitated the crisis. During the past two decades, governmental policies in the U.S., U.K. and Europe encouraged consolidation and conglomeration within the financial services industry. Domestic and international mergers among commercial and investment banks produced a leading group of seventeen large complex financial institutions (LCFIs). Those LCFIs dominated domestic and global markets for securities underwriting, syndicated lending, asset- backed securities (ABS), over-the-counter (OTC) derivatives, and collateralized debt obligations (CDOs). Universal banks pursued an “originate to distribute” (OTD) strategy, which.included (i) originating consumer and corporate loans, (ii) packaging loans into ABS and CDOs, (iii) creating OTC derivatives whose values were derived from loans, and (iv) distributing the resulting Electronic copy available at: http://ssrn.com/abstract=1403973 2009] THE DARK SIDE OF UNIVERSAL BANKING 964 securities and other financial instruments to investors. LCFIs used the OTD strategy to maximize their fee income, reduce their capital charges, and transfer to investors the risks associated with securitized loans. Securitization enabled LCFIs to extend huge volumes of home mortgages and credit card loans to nonprime borrowers. By 2006, LCFIs turned the U.S. housing market into a system of “Ponzi finance,” in which borrowers kept taking out new loans to pay off old ones. When home prices fell in 2007, and nonprime homeowners could no longer refinance, defaults skyrocketed and the subprime financial crisis began. Universal banks also followed reckless lending policies in the commercial real estate and corporate sectors. LCFIs included many of the same aggressive loan terms (including interest-only provisions and high loan-to-value ratios) in commercial mortgages and leveraged corporate loans that they included in nonprime home mortgages. In all three markets, LCFIs believed that they could (i) originate risky loans without screening borrowers and (ii) avoid post-loan monitoring of the borrowers’ behavior because the loans were transferred to investors. However, LCFIs retained residual risks under contractual and reputational commitments. Accordingly, when securitization markets collapsed in mid-2007, universal banks were exposed to significant losses. Current regulatory policies—which rely on “market discipline” and LCFIs’ internal “risk models”—are plainly inadequate to control the proclivities in universal banks toward destructive conflicts of interest and excessive risk-taking. As shown by repeated government bailouts during the present crisis, universal banks receive enormous subsidies from their status as “too big to fail” (TBTF) institutions. Regulation of financial institutions and financial markets must be urgently reformed in order to eliminate (or greatly reduce) TBTF subsidies and establish effective control over LCFIs. 2009 THE DARK SIDE OF UNIVERSAL BANKING ARTICLE CONTENTS I. INTRODUCTION 966 II. CONSOLIDATION AND CONVERGENCE AMONG FINANCIAL CONGLOMERATES INTENSIFIED RISKS IN DOMESTIC AND GLOBAL FINANCIAL MARKETS AFTER 1990 972 A. THE RE-ENTRY OF COMMERCIAL BANKS INTO SECURITIES MARKETS 972 B. CONSOLIDATION IN THE BANKING AND SECURITIES INDUSTRIES 975 C. CONVERGENCE BETWEEN THE ACTIVITIES OF BANKS AND SECURITIES FIRMS 980 D. RISING LEVELS OF SYSTEMIC RISK IN DOMESTIC AND GLOBAL FINANCIAL MARKETS 994 III. UNIVERSAL BANKS WERE THE PRIMARY PRIVATE-SECTOR CATALYSTS FOR THE SUBPRIME FINANCIAL CRISIS 1002 A. AN UNSUSTAINABLE CREDIT BOOM OCCURRED IN THE U.S. BETWEEN 1991 AND 2007 1002 B. FINANCIAL CONGLOMERATES PROMOTED THE CREDIT BOOM, WHICH EXPOSED HOUSEHOLDS, NONFINANCIAL BUSINESSES AND FINANCIAL INSTITUTIONS TO CATASTROPHIC LOSSES 1008 C. FINANCIAL CONGLOMERATES BECAME THE EPICENTER OF THE SUBPRIME FINANCIAL CRISIS 1043 IV. CONCLUSION AND POLICY IMPLICATIONS 1046 The Dark Side of Universal Banking: Financial Conglomerates and the Origins of the Subprime Financial Crisis ARTHUR E. WILMARTH, JR.  Remember this crisis began in regulated entities . . . . This happened right under our noses. 1 God knows, some really stupid things were done by American banks and by American investment banks . . . . To policy makers, I say where were they? They approved all these banks . . . .We gave [consumers] weapons of mass destruction to borrow too much . . . .” 2 I. INTRODUCTION The global economy is currently experiencing the “most severe financial crisis since the Great Depression.” 3 The ongoing crisis has battered global financial markets and has triggered a world-wide  Professor of Law, George Washington University Law School, Washington, DC. I wish to thank Dean Fred Lawrence and the George Washington University Law School for a summer research grant that supported my work on this article. I am most grateful for the excellent research assistance provided by my former students, Christopher Scott Pollock and Blake Reese, and also by Germaine Leahy, Head of Reference for the Jacob Burns Law Library. Finally, I greatly appreciate very helpful comments by, and conversations with, Larry Cunningham, Theresa Gabaldon, Anna Gelpern, Ann Graham, Patricia McCoy, Larry Mitchell, Heidi Schooner, and Michael Taylor about various topics discussed in this article. Unless otherwise indicated, this article includes developments through April 15, 2009. 1 Jill Drew, Frenzy, WASH. POST, Dec. 16, 2008, at A1, available at LEXIS, News Library, WPOST File (quoting Paul S. Atkins, former member of the Securities and Exchange Commission). 2 Edward Evans & Christine Harper, Dimon Blames Banks, Regulators for Debt Problems, BLOOMBERG.COM, Jan. 29, 2009, http://www.bloomberg.com/apps/news?pid=20601208&sid= afYmYskaGvTk (quoting remarks by Jamie Dimon, Chief Executive Officer of JP Morgan Chase, at the World Economic Forum in Davos, Switzerland). 3 Markus K. Brunnermeier, Deciphering the Liquidity and Credit Crunch, 2007–08, 23 J. ECON. PERSPECTIVES No. 1, 77, 77 (Winter 2009); see also Stijn Claessens et al., What Happens during Recessions, Crunches and Busts? (Dec. 1, 2008), available at http://ssrn.com/abstract=1318825 (describing the current “financial turmoil” as “the most severe global financial crisis since the Great Depression”); Diana I. Gregg, World Is in Recession in 2009 in Wake of Financial Sector Crisis, 92 BANKING REP. (BNA) 48 (Jan. 6, 2009), available at LEXIS, News Library, BNABNK File (citing World Bank assessment that the current financial crisis is the “most serious since the 1930s”); Speech by Federal Reserve Board Chairman Ben S. Bernanke at the Council on Foreign Relations, Mar. 10, 2009, available at http://www.federalreserve.gov/newsevents/speech/bernanke20090310a.htm [hereinafter Bernanke CFR Speech] (acknowledging that “[t]he world is suffering through the worst financial crisis since the 1930s”). 2009] THE DARK SIDE OF UNIVERSAL BANKING 967 recession. 4 Global stock market values declined by $35 trillion during 2008 and early 2009, and global economic output is expected to fall in 2009 for the first time since World War II. 5 In the United States, where the crisis began, markets for stocks and homes have suffered their steepest downturns since the 1930s and have driven the domestic economy into a steep and prolonged recession. 6 The total market value of publicly-traded U.S. stocks slumped by more than $10 trillion from October 2007 through February 2009. 7 In addition, the value of U.S. homes fell by an estimated $6 trillion between mid-2006 and the end of 2008. 8 U.S. gross domestic product declined sharply during the second half of 2008, and 4.4 million jobs were lost during 2008 and the first two months of 2009. 9 In early 2009, the U.S. appeared to be “trapped in a vortex of plunging consumer demand, rising joblessness, and a deepening crisis in the banking system.” 10 4 See, e.g., Anthony Faiola, Downturn Accelerates as It Circles the Globe, WASH. POST, Jan. 24, 2009, at A1, available at LEXIS, News Library, WPOST File (reporting that “the burst of the biggest credit bubble in history” had led to a weakening of “real economies around the world”); Gregg, supra note 3 (stating that the financial crisis “has left no country unaffected”); Joanna Slater, Year-End Review of Markets & Finance 2008—Global Markets Are in for Another Tough Slog, WALL ST. J., Jan. 2, 2009, at R4, available at LEXIS, News Library, WSJNL File (reporting that “global stock markets collapsed in 2008” as the value of publicly-traded stocks in markets outside the U.S. “fell by almost half”). 5 Shamim Adam, Global Financial Assets Lost $50 Trillion Last Year, ADB Says, BLOOMBERG.COM, Mar. 9, 2009, http://www.bloomberg.com/apps/news?pid=20601087&sid=aZ1kc J7y3LDM&refer=worldwide; Anthony Faiola, U.S. Downturn Dragging World Into Recession, WASH. POST, Mar. 9, 2009, at A01, available at LEXIS, News Library, WPOST File. 6 Conor Dougherty & Kelly Evans, Economy in Worst Fall Since ’82—Output Sank 6.2% Last Quarter, WALL ST. J., Feb. 28, 2009, at A1, available at LEXIS, News Library, WSJNL File (reporting that U.S. gross domestic profit (GDP) recorded its “steepest [quarterly] dropoff since the depths of the 1982 recession”); Peter A. McKay, Dow Falls 119.15 Points, Losing 12% in February, WALL ST. J., Feb. 28, 2009, at B1, available at LEXIS, News Library, WSJNL File (reporting that the Dow Jones Industrial Average recorded its worst six-month decline since 1932 and had lost more than fifty percent of its value since October 2007); Adam Shell, S&P Sinks Beyond November Low; Index’s Bear Market Loss Expands to 52.5%, USA TODAY, Feb. 24, 2009, at 1B, available at LEXIS, News Library, USATDY File (reporting that the S&P 500 index had lost 52.5% since its peak, “its biggest decline since the 1930s”). 7 Shell, supra note 6 (reporting that “since the October 2007 top, the [U.S.] stock market, as measured by the Dow Jones Wilshire 5000, has declined $10.4 trillion in value”). 8 Dan Levy, U.S. Property Owners Lost $3.3 Trillion in Home Value, BLOOMBERG.COM, Feb. 3, 2009, http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=aE29HSrxA4rI (reporting an estimate by Zillow that “[a]bout $6.1 trillion of value has been lost since the housing market peaked in the second quarter of 2006”); see also Timothy R. Homan, U.S. Household Net Worth Had Record Decline in Fourth Quarter, Bloomberg.com, Mar. 13, 2009 (reporting that the net worth of U.S. households fell by $12.8 trillion between September 30, 2007, and December 31, 2008, due to drops in the values of stocks and homes). 9 See Dougherty & Evans, supra note 6 (reporting that the “[U.S.] gross domestic product declined at a 6.2% annual rate in the fourth quarter of 2008”); Peter S. Goodman & Jack Healy, Job Losses Hint at Vast Remaking of U.S. Economy, N.Y. TIMES, Mar. 7, 2009, at A1, available at LEXIS, News Library, NYT File (reporting that the U.S. “unemployment rate surged to 8.1. percent [in February 2009] . . . its highest level in a quarter-century”). 10 Jeff Zeleny & Edmund L. Andrews, With Grim Job Loss Figures, No Sign That Worst Is Over, N.Y. TIMES, Feb. 7, 2009, at B1, available at LEXIS, News Library, NYT File; see also Goodman & 968 CONNECTICUT LAW REVIEW [Vol. 41:963 By March 2009, “the continuing collapse in financial markets around the globe reflected an absence of faith” in the ability of governments and regulators to deal with the financial crisis. 11 The turmoil in financial markets reflected deep concerns among investors about the viability of major financial institutions. Commercial and investment banks and insurance companies around the world reported more than $1.1 trillion of losses between the outbreak of the financial crisis in mid-2007 and March 2009. In response to those losses, and to prevent the collapse of the global financial system, central banks and governments in the United States (U.S.), United Kingdom (U.K.) and Europe provided almost $9 trillion of support in the form of emergency liquidity assistance, capital infusions, asset purchase programs, and financial guarantees. U.S. federal agencies extended about half of that support. Neverthless, the ability of global financial markets to recover from the present crisis remained in serious doubt in April 2009. 12 Seventeen large universal banks accounted for more than half of the $1.1 trillion of losses reported by the world’s banks and insurance companies. Twelve of those universal banks suffered serious damage, including (i) six institutions that failed or were nationalized to prevent their failure, and (ii) three other institutions that were placed on government- funded life support. 13 In view of the huge losses suffered by these institutions, and the extraordinary governmental assistance they received, they are the clearly the epicenter of the global financial crisis. This Article argues that they were also the principal private-sector catalysts for the enormous credit boom that led to the crisis. Part II of this Article describes the growth of large universal banks and Healy, supra note 9 (quoting economist Robert Barbera’s description of “the violent downward trajectory” in the U.S. economy). 11 Neil Irwin, In Free-Fall, Stocks Hit Lowest Mark Since ’97, WASH. POST, Mar. 3, 2009, at A1, available at LEXIS, News Library, WPOST File; see also Michael Lewis & David Einhorn, The End of the Financial World As We Know It, N.Y. TIMES, Jan. 4, 2009, WK 9, available at LEXIS, News Library, NYT File (stating that “the collapse of [the U.S.] financial system . . . inspired not merely a national but a global crisis of confidence”). 12 See infra Part III.C.; see also Timothy R. Homan, IMF Says Global Losses From Credit Crisis May Hit $4.1 Trillion, BLOOMBERG.COM, April 21, 2009 (stating that, according to a report issued by the International Monetary Fund, (i) “[w]orldwide losses tied to rotten loans and securitized assets may reach $4.1 trillion by the end of 2010 as the recession and credit crisis exact a higher toll on financial institutions,” and (ii) “‘[co]nfidence.in the international financial system remains fractured and systemic risks elevated’”); Liz Rappaport & Serena Ng, New Fears As Credit Markets Tighten, WALL ST. J., Mar. 9, 2009, at A1 (quoting a prominent financial executive’s comment that “[t]here’s fear out there that’s driving down every asset class simultaneously. It illustrates a lack of investor confidence in the government’s plan for fixing the financial infrastructure”). 13 See infra notes 421-30 and accompanying text. As used in this Article, the term “universal bank” refers to an organization that has authority to engage, either directly or through affiliates, in the banking, securities and insurance businesses. Arthur E. Wilmarth, Jr., The Transformation of the U.S. Financial Services Industry, 1975–2000: Competition, Consolidation, and Increased Risks, 2002 U. ILL. L. REV. 215, 223 n.23. In addition, unless otherwise indicated, the term “universal bank” is used interchangeably with “financial conglomerate” and “large complex financial institution” (LCFI). 2009] THE DARK SIDE OF UNIVERSAL BANKING 969 their success in establishing leadership positions in many sectors of the financial markets. During the past two decades, as explained in Parts II.A. and II.B., governmental policies in the U.S., U.K. and Europe encouraged massive consolidation and conglomeration within the financial services industry. The Gramm-Leach-Bliley Act of 1999 was a prominent domestic example of an international regulatory trend in favor of universal banking. Domestic and international mergers among commercial and investment banks produced a dominant group of large complex financial institutions (LCFIs). By 2007, as discussed in Part II.C., seventeen LCFIs effectively controlled domestic and global markets for debt and equity underwriting, syndicated lending, asset-backed securities (ABS), over-the-counter (OTC) derivatives, and collateralized debt obligations (CDOs). As explained in Part II.D.1., universal banks pursued an “originate-to- distribute” (OTD) strategy. The OTD business model included (i) originating and servicing consumer and corporate loans, (ii) packaging those loans into ABS and CDOs, (iii) creating additional financial instruments, including synthetic CDOs and credit default swaps (CDS), whose values were derived in complicated ways from the underlying loans, and (iv) distributing the foregoing securities and financial instruments to investors. LCFIs used the OTD strategy to maximize their fee income, reduce their capital charges, and transfer to investors (at least ostensibly) the risks associated with securitized loans and other structured-finance products. Even before the subprime lending boom began in 2003, some observers began to raise questions about the risks posed by the new universal banks. As described in Part II.D.2., LCFIs played key roles in promoting the dotcom-telecom boom in the U.S. stock market between 1994 and 2000, which was followed by a devastating bust from 2000 to 2002. Many leading universal banks were also involved in a series of scandals involving Enron, WorldCom, investment analysts, initial public offerings, and mutual funds during the same period. Nevertheless, Congress did not seriously consider the question of whether financial conglomerates threatened the stability of the financial markets and the general economy. Political leaders assumed that federal regulators and market discipline would exercise sufficient control over the growing power of universal banks. As explained in Part III.A., the U.S. (like the U.K. and some European nations) experienced an enormous credit boom between 1991 and 2007. Within the domestic nongovernmental sector, household debts rose by $10 trillion (to $13.8 trillion), nonfinancial business debts grew by $6.4 trillion (to $10.1 trillion), and financial sector debts increased by $13 trillion (to $15.8 trillion). The credit boom accelerated at a particularly rapid rate after 2000, and the financial services industry captured an unprecedented share of corporate profits and gross domestic profit. Governmental 970 CONNECTICUT LAW REVIEW [Vol. 41:963 policies (including an overly expansive U.S. monetary policy and currency exchange rate policies pursued by foreign governments) were important factors that encouraged credit growth. In addition, as discussed in Part III.B., universal banks were the leading private-sector catalysts for the credit boom. During the past two decades, and particularly after 2000, LCFIs used mass-marketing programs, automated loan processing, and securitization to extend huge volumes of high-risk home mortgage loans and credit card loans to nonprime borrowers. Federal laws facilitated the creation of nationwide lending programs by LCFIs, because federal laws preempted state usury laws and state consumer protection laws. Unfortunately, Congress and federal regulators did not establish adequate federal safeguards to protect consumers against abusive lending practices by federally chartered depository institutions and their subsidiaries and agents. As described in Part III.B.3., LCFIs played leading roles as direct lenders, warehouse lenders and securitizers for nonprime home mortgages. The volume of nonprime mortgages rose from $250 billion in 2001 to $1 trillion in 2006. Nearly 10 million nonprime mortgages were originated between 2003 and mid-2007. LCFIs used securitization to spur this dramatic growth in nonprime lending. By 2006, LCFIs packaged four- fifths of subprime mortgages and nine-tenths of “Alt-A” mortgages into residential mortgage-backed securities (RMBS). As the securitized share of nonprime lending increased, lending standards deteriorated. LCFIs increasingly offered subprime mortgages with low payments (based on introductory “teaser” rates) for two or three years, followed by a rapid escalation of interest rates and payments. As a practical matter, borrowers who accepted such loans were forced to refinance before their “teaser” periods expired, and they could do so only as long as home prices kept rising. By 2006, LCFIs had turned the U.S. housing market into a system of “Ponzi finance,” in which nonprime borrowers had to keep taking out new loans to pay off their old ones. When home prices stopped rising in 2006 and collapsed in 2007, nonprime borrowers could not refinance, defaults skyrocketed, and the subprime financial crisis began. Financial conglomerates aggravated the risks of nonprime mortgages by creating multiple financial bets based on those mortgages. LCFIs re- securitized lower-rated tranches of RMBS to create CDOs, and then re- securitized lower-rated tranches of CDOs to create CDOs-squared. LCFIs also created synthetic CDOs and wrote CDS to create additional financial bets based on nonprime mortgages. By 2007, the total volume of financial instruments derived from nonprime mortgages was at least twice as large as the $2 trillion in outstanding nonprime mortgages. LCFIs created the impression that they were transferring the risks of their lending and securitization activities to far-flung investors. In fact, however, LCFIs retained significant exposures to nonprime mortgages because (i) LCFIs 2009] THE DARK SIDE OF UNIVERSAL BANKING 971 kept RMBS and CDOs in their “warehouses,” and (ii) LCFIs transferred RMBS and CDOs to off-balance-sheet conduits that relied on the sponsoring LCFIs for explicit or implicit support. Thus, in important respects, LCFIs pursued an “originate to not really distribute” strategy, due to their overwhelming desire to complete more transactions and earn more fees. Universal banks created similar risks with their credit card operations. While the housing boom lasted, universal banks expanded credit card lending to nonprime borrowers and encouraged those borrowers to use home equity loans to pay off their credit card balances. As in the case of nonprime home mortgages, LCFIs ignored the risks of nonprime credit card loans because they could securitize most of the loans. However, the securitization market for credit card loans shut down in 2008, just as it had done for subprime mortgages in 2007. As discussed in Part III.B.4., universal banks followed similarly reckless lending policies in the commercial real estate and corporate sectors. LCFIs used securitization techniques to promote a dramatic increase in commercial mortgage lending and leveraged corporate lending between 2003 and mid-2007. LCFIs used many of the same aggressive loan terms (including interest-only provisions and high loan-to-value ratios) for commercial mortgages and leveraged corporate loans that they used for nonprime home mortgages. In both markets, as with home mortgages, securitization created perverse incentives for lenders and ABS underwriters. Lenders and ABS underwriters (which often were affiliated subsidiaries of LCFIs) believed that they could (i) originate risky loans without properly screening borrowers and (ii) avoid costly post-loan monitoring of the borrowers’ behavior because, in each case, the loans were transferred to investors. Again, however, LCFIs often retained residual risk exposures. This was particularly true in the market for leveraged buyouts, because LCFIs frequently agreed to provide “bridge” financing if there were not enough investors to complete the transactions. Once again, the ability of LCFIs to control their risks was undercut by their single-minded focus on maximizing transactions and fees. Accordingly, when the securitization markets for commercial mortgages and leveraged corporate loans collapsed in mid-2007, universal banks were exposed to significant losses. As discussed in Parts III.C. and IV, the massive losses suffered by LCFIs, and the extraordinary governmental assistance they have received, demonstrate that they bear primary responsibility for the credit boom and the global financial crisis. Current regulatory policies – which rely heavily on “market discipline” and LCFIs’ internal “risk models” – are plainly inadequate to control the strong tendencies in universal banks toward destructive conflicts of interest and excessive risk-taking. Moreover, repeated government bailouts during the present crisis confirm that [...]... Company Act of 1956, Pub L No 511, 70 Stat 133 2009] THE DARK SIDE OF UNIVERSAL BANKING 973 Citigroup to exist on a permanent basis However, based on an exemption in the BHC Act, the FRB allowed Citigroup to offer securities and insurance services beyond the scope of the BHC Act for up to five years.20 The FRB’s approval of the Citigroup merger placed great pressure on Congress to repeal the Glass-Steagall... affiliate of the sponsor) to underwrite the sale of ABS to investors After the underwriting has been completed, the proceeds paid by investors for the ABS are transferred to the sponsor in payment for the loans Also, in many cases, the SPE issuer hires the sponsor to act as servicing agent for the securitized loans.85 In early securitizations of home mortgages during the 1970s and 1980s, the residential... 3, 2009] THE DARK SIDE OF UNIVERSAL BANKING 987 During the past decade, most RMBS and other types of ABS were divided into three general classes of tranches—senior, mezzanine and junior Senior tranches were given the highest priority to receive cash flows from payments on the pooled loans until those securities were fully paid, and cash flows then trickled down sequentially to the mezzanine and junior... note 13, at 388–90, 403 2009] THE DARK SIDE OF UNIVERSAL BANKING 989 95 $680 billion of ABS backed by other types of consumer credit At the end of 2007, GSE-issued RMBS and private label RMBS accounted for almost two-thirds of all outstanding home mortgages, while consumer ABS accounted for more than a quarter of all outstanding consumer loans.96 The securitized share of both sectors increased significantly... Gross market values of OTC derivatives—an alternative measure of their economic significance—are considerably smaller than notional values114 but nevertheless confirm the importance of OTC derivatives At the end of 2007, the gross market values of outstanding OTC derivatives in global markets were $16 trillion, equal to one-ninth of the total market values of all outstanding equity and debt securities... investment banking, securitization, and sales of loans, derivatives and other assets produced a significant rise in the overall risk of those banks, as measured by the volatility of their stock market returns.138 Other studies determined that consolidation and conglomeration in the U.S and European banking industries generated higher levels of systemic risk on both sides of the Atlantic.139 In particular,... Bubble and the Collapse of Enron and WorldCom Further evidence of the risks posed by financial conglomerates appeared during the boom -and- bust cycle that occurred in the U.S economy from 1994 through 2002 In future work, I intend to undertake a more detailed analysis of the role played by universal banks during that period, which witnessed the rise and fall of many Internet (“dotcom”) and telecommunications... n.491 Banks and other public companies are required to disclose both the notional value and the “fair value” of their derivatives under Statement of Financial Accounting Standards (SFAS) Nos 119 and 133 The disclosure of “fair value” under SFAS No 133 is based on mark-to-market principles See Li Wang et al., The ValueRelevance of Derivatives Disclosures by Commercial Banks: A Comprehensive Study of Information... distributing portions of those loans to investors, and lead banks seek to retain the smallest possible pieces of those loans on their balance sheets.62 Lead banks negotiate the terms of a syndicated loan with the borrower and then sell portions of the loan to banks and other institutional investors who agree to join the syndicate Lead banks also take responsibility for servicing the loan, including (i)... showing that the size of the market exceeded $1 trillion in each of those years except 2009] THE DARK SIDE OF UNIVERSAL BANKING 983 and Citigroup controlled about three-fifths of the U.S syndicated lending market from 2000 through 2007.68 During the same period, Wachovia, Credit Suisse, Deutsche, UBS, Barclays, RBS and Wells Fargo also ranked among the largest U.S syndicated lenders.69 From the late 1990s . Article The Dark Side of Universal Banking: Financial Conglomerates and the Origins of the Subprime Financial Crisis ARTHUR E. WILMARTH, JR. Since the subprime financial crisis began. The Dark Side of Universal Banking: Financial Conglomerates and the Origins of the Subprime Financial Crisis ARTHUR E. WILMARTH, JR.  Remember this crisis began in regulated. trillion of losses between the outbreak of the financial crisis in mid-2007 and March 2009. In response to those losses, and to prevent the collapse of the global financial system, central banks and